Number 10 has turned down an appeal for cash to fund a national Early Intervention Foundation, designed to act as a driver for a big increase in spending on improving the formative early years of children in problem families.

Graham Allen, the Labour MP and author of a report commissioned by the government, had personally visited Number 10 to ask for a £10m commitment to produce half the funding for an Early Intervention Foundation, but was turned down and told to come back later in the year to see whether government cash was necessary. He has promised to find half the funding from outside government.

The Early Intervention Foundation, independent from the government, is central to Allen's vision and would act as the curator of an approved list of successful early intervention projects, as well as being the incubator for what could turn into a £1bn social investment market.

Allen believes the City can develop this social investment market using a mixture of social bonds, tax credits or tax-free ISAs. The investor recoups their money through the cash saved by the government from lower than projected public spending on failed families and individuals in terms of prison, drug addiction and welfare.

Allen is understood to have gone to Number 10 to seek funding, but will now have to wait for a formal government response to his report not due until the autumn.

Allen in his report had urged the government to back his proposals quickly, writing: "A relatively new government still has the freshness and energy to take on the vested interests and naysayers. Private and philanthropic capital is beginning to explore new forms of finance and local authorities and third-sector providers are enthusiastically embracing early intervention as a long-term sustainable alternative to the permanent firefighting of social ills."

The funding issue is now likely to be examined by the social justice cabinet committee chaired by the work and welfare secretary, Iain Duncan Smith.

The Treasury will also examine whether a payments by results model can be established so that investors only receive a return if early intervention achieves specified measurable goals.

The Treasury is attempting to build payments by results as a model for all public services, but it is hard to prove scientifically that early intervention led to specific outcomes for children later in life.

In his report Allen also proposed a 1% annual shift in government spending from what he describes as late intervention, such as crime or unemployment, towards early intervention.

Allen argues there is an urgent need to use current funding on early years more effectively, as well as to mobilise additional investment from sources outside the public sector.

Previous governments, Allen reports, "have spent billions and billions of pounds year after year for many decades and for often only marginal impact (certainly on the social and emotional development of children)."

Children with untreated behavioural problems go on to cost the taxpayer an average £70,000 each by the time they reach 28, 10 times the cost of children without problems. It costs £220,000 to place a child in a secure children's home and £59,000 a year, on average, to place a child in a young offender's institution.

Allen said work was under way to try to measure the effectiveness of early intervention programmes such as parenting courses, nurse family partnerships and Sure Start. The Social Research Unit at Dartington is trying to translate work by the Washington State Institute for Public Policy into a cost-benefit model for use in Britain.

He also calls for a £200m early intervention fund working closely with the Big Society Bank.

Allen said the fund should develop a range of products for potential investors and initially raise £27m to support pilots in the 15 early intervention places recommended in Allen's first report

Allen states in his report that he has established a shadow Early Intervention Foundation including individuals from the Big Society Bank, the National Lottery, the Metropolitan police, the Mayor's Fund for London, private financiers and others.